Finance Committee on Nov. 17th, 2016

[Trevor McGowan]

It is, and I apologize for getting a little bit into the weeds, but I think that's important to understand it.

There are a lot of techniques used in cross-border mergers and acquisitions planning. This doesn't affect the most common of them. For example, I think probably tax planning 101 is to establish a Canadian acquisition corporation, fully funded with the purchase price by a non-resident, who would use it to buy the Canadian target. That would not be affected.

What would be affected is, as I described earlier, in-house reorganizations that, essentially with a non-resident parent on top, try to get into the exception we're dealing with in subsection 212.1(4), but there are a number of examples, such as the one I just described, that would not be affected. I think it's probably, and certainly from my experience, the most common way of doing it.

[Robert-Falcon Ouellette, Liberal, Winnipeg Centre, MB]

Thank you very much.

[The Chair, Liberal, Wayne Easter]

Thank you, Robert.

Go ahead, Mr. Sorbara.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Thank you, Mr. Chair.

Thank you for a most insightful commentary on the questions.

I'm looking at the amendments to the anti-avoidance rules in dealing with the multiplication of access to the small business deduction. I think this component has received a lot of press and a lot of commentary from various stakeholders. I do want to ask a couple of questions. How frequently is this used by partnerships to multiply the small business deduction?

[James Greene]

It's a type of planning that had not become infrequent. The government has provided an estimate of the revenue gain from restricting the availability of the small business deduction. It has always been the long-standing policy that a business, whether it's owned by one individual or by several individuals operating together in a partnership, should be entitled to one small business deduction, so they're entitled to the low small business rate on $500,000 a year of taxable income.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

First of all, do we have an estimate? What would be the revenue gain from this amendment?

[James Greene]

In 2017-18, the two measures in the act are expected to raise about $70 million a year of revenue, and on an ongoing basis it's a little bit lower than that.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Do we have any idea in which sectors partnerships are most commonly used and which would be impacted? It would be one sector over another. Do you have any commentary on that front?

[Trevor McGowan]

We know that the rules apply regardless of sector. They apply to all taxpayers in this situation, and it's not targeted at one industry or another. We have heard comments from lawyers and accountants, and I'm assuming the commentary from the Canadian Medical Association is related to this because we've heard from doctors as well, but there's nothing in this restricting it to a particular segment of the economy or type of business. It's a rule of general application. We certainly heard from stakeholders, professionals, lawyers, accountants, doctors, and maybe dentists. I'm not sure about that.

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

Thank you for filling some holes in there for my knowledge.

Paragraph (g) in the summary of part 1 refers to amendments to clarify the tax consequences “of a disposition of an interest in a life insurance policy”. I read that over. What is the reason for the change? What's the rationale behind the change on that, please?

[Trevor McGowan]

It essentially addresses two issues relating to the use of life insurance products to extract profits from a corporation free of tax. I'll discuss them separately.

The first—I'll call it a loophole—involves the fact that when a corporation receives proceeds from life insurance, the amount of the proceeds is added to what's called their capital dividend account, but it's not the whole amount of the proceeds. It's the amount by which the proceeds exceed the policyholder's adjusted cost basis in the policy. The benefit of the capital dividend account is you can pay capital dividends out of a corporation to shareholders free of Canadian tax.

As I said, the formula for an addition to your capital dividend account is based upon your proceeds from the insurance policy, the amount by which it exceeds the adjusted cost basis to the policyholder. However, if the proceeds go to one corporation in a group, and the policyholder is another corporation, for example, that type of planning was used so that the entity receiving the life insurance proceeds wasn't a policyholder, so it didn't have an adjusted cost basis. Therefore, instead of $100 proceeds minus a $20 cost base for an $80 capital dividend account increase, they could just add the $100. The first set of amendments clarifies that n that situation, you take into account the basis of the policy, and even if it's held by another entity, it's still the same calculation.

The second type of planning involved the transfer of life insurance proceeds or life insurance policies to a non-arm's-length corporation. Normally when you transfer life insurance policies to an arm's-length person, your proceeds are included in your income. However, there's a special rule in the tax act that deals with transfers of these life insurance policies to related companies. It's called the policy transfer rule. It says that you're considered to receive, as the transferor, the cash surrender value in respect to the policy. That's the amount of cash you could get for the policy if you were to transfer the policy to the issuer of the policy.

That, in many cases, is going to be the value of the policy, but that's not always the case. If, for example, there's a reasonable likelihood that the policy is going to pay out sooner than initially anticipated—perhaps the insured is sick, or for whatever reason—

[Francesco Sorbara, Liberal, Vaughan—Woodbridge, ON]

If I can just interject, I believe it is part 1 of these income tax measures dealing with the efficacy of the tax system or the tax code in bringing in a number of measures that clean up the tax code and make it more efficient overall. The exact details, without having to go through the tax code, are sometimes flying over my head. I will admit that, but I think I understand the gist of your comments. I am happy with your explanation. Thank you.

[The Chair, Liberal, Wayne Easter]

Thank you, Mr. Sorbara.

Mr. Caron, go ahead.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Mr. Sorbara asked one of the questions that I wanted to ask.

I'd like to come back to the issue raised by Mr. Albas: the costs of meeting the requirements of the common reporting standard.

When we talk to credit unions or the caisses populaires that have had to comply with the requirements of the Foreign Account Tax Compliance Act, they tell us about the fairly high costs that they have to bear for the very low risks that one of their members or clients is likely to criticize or report.

Canada isn't the only place with a credit union or caisse populaire structure. Wouldn't it be possible to get a general exemption when, as in Canada's case, the risks are low because of the particular legal structure of these credit unions or caisses populaires?

[James Greene]

Thank you, Mr. Chairman. I think it's a fair question.

It certainly was recognized in the international negotiations that led to this common reporting standard that this imposes a burden on institutions and that it has a cost. An attempt was made to try to develop principles and rules that could be applied to minimize those costs to the extent possible. Given the model of the U.S. FATCA approach, which carved out small institutions, as I say, that idea was specifically considered and debated.

The prevailing view in the international community was that if small institutions were carved out from the standards, and even though presently they may be little used by non-residents, it could create a pathway. People would know that it's safe to put money in these places and it wouldn't get reported back to your home country. There was a lot of nervousness about that.

[Guy Caron, NDP, Rimouski-Neigette—Témiscouata—Les Basques, QC]

Thank you.

[The Chair, Liberal, Wayne Easter]

Is there anyone else?

Mr. Albas, go ahead.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

First of all, I'm always happy when I see legislation, because that means I may be useful on behalf of my constituents, Mr. Chair.

In regard to valuation for derivatives, the Government of Canada had been given the authority by Parliament, or the authority has been delegated by Parliament to the finance minister, to regulate in the area of derivatives. It was pretty wide open, so I'm just wondering why legislation is being used, rather than the statutory authority that was delegated to do regulations.

[Trevor McGowan]

I would say, in answer to that question, that were we to put these changes in the regulations....

First, I should actually give a little bit of background on what they do. For taxpayers who have derivatives, they're held as inventory. These rules set how they can be treated for tax purposes. Specifically they prevent taxpayers from using what's called the “lower of cost and market” method for valuing these derivatives they hold as inventory.

Under the basic rules in the Income Tax Act, if you have inventory, you can use this lower of cost and market method. I'm not certain that if something were put in the regulations, it would be able to override the tax rules in the Income Tax Act.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

It's more the tax consequences from the use of derivative products than the actual regulation of the products themselves.

[Trevor McGowan]

That's correct. It really applies to the holding of them as inventory and this one specific lower of cost and market method.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

Okay.

I may have missed it, Mr. Chair, because some of us are slower than others. On the Canada child benefit indexation, could you just cover what that will cost to government? I do know there was reference in the annex of the fall economic update.

Second, although I'm sure the government would say it's just a logical follow-through of ongoing policy, why wasn't this included in the original legislation? Really, I think Bill C-2 was one of the first pieces that the government put out. Why wasn't it included in the original legislation?

[Pierre LeBlanc]

On your first question, as you say, in the fall economic statement we reported that the cost of indexing in the 2020-21 fiscal year would be $505 million, and in the 2021-22 fiscal year it would be $1.2 billion.

On your second question, the government didn't make the decision until after the first budget implementation act, Bill C-15, was tabled in Parliament. That's why it's in the second budget implementation act.

[Dan Albas, Conservative, Central Okanagan—Similkameen—Nicola, BC]

Okay. Thank you.

[The Chair, Liberal, Wayne Easter]

Mr. Ouellette, the floor is yours.